The SLL door opens in Australia
ING Bank (ING) was the global pioneer of sustainability-linked loans (SLLs). In August, the bank hosted a roundtable with KangaNews in Sydney to discuss the product’s emergence and its relevance to Australian corporates. Borrowers say SLLs could gain traction above and beyond what green bonds have been able to deliver.
Swiss What is the history behind the SLL and what has growth trajectory been like so far?
One of the ways we want to do this is to incentivise our clients. It really doesn’t matter what stage of the sustainability journey they are at, because our aim is to help them take ambitious steps forward, to be their partner in this process and incentivise them from the ever-important pricing perspective.
ING was the sole sustainability coordinator for the first-ever SLL transaction, which was a €1 billion (US$1.1 billion) syndicated loan for Royal Phillips completed in April 2017. Pricing was linked to the up- and downside of the independent environmental, social and governance (ESG) ratings assigned by Sustainalytics.
We didn’t expect the market to pick up on the SLL instrument quite so quickly. One of the reasons it has, we think, is because it is so simple in concept even though the mechanics behind its definition are ambitious.
By the end of last year, around US$80 billion of syndicated SLL loans had been issued. In 2019, volume is already surpassing the previous year on a pro-rata basis with about US$45 billion of SLLs priced by the end of H1. We are excited to see the growth and geographic diversity of this product across different regions – especially Asia Pacific.
Swiss What are ING’s early conclusions about the relevance of the product here in Australia?
The market needs products to help move the dial. The treasurers and chief financial officers that have been enlightened about the sustainability journey are eager to use and support the development of these products.
What has been a bit slower is the know-how part, which is ever evolving around best practice. The concepts themselves are not challenging. With the right partners on the journey, we believe the market will significantly grow in Australia in the next year or two.
Craig Adelaide Airport signed Australia’s first-ever bilateral SLL in December 2018. What was the strategy and process?
We quickly worked out that a green bond wasn’t an option for us. We had some qualifying property assets, but our core aviation assets such as the terminal and airfield didn’t have traditional green accreditations. We were therefore building up our asset pool with relatively lower-value items like solar panels.
We then asked our banks about broader sustainability options, which developed into a couple of our banks proposing an ESG-linked loan. We liked the concept and felt it was more closely aligned with Adelaide Airport’s holistic approach to sustainability.
We were keen to do an SLL from the outset as we see this becoming a normal part of accessing funding in the future. We wanted to understand how it might work for us and to demonstrate to others that we were already heading in this direction.
We had also just rolled out a new sustainability policy which is essentially about embedding sustainability within our day-to-day business. We believed it was a good opportunity to demonstrate to the business as a whole how this could be achieved through embedding sustainability within our financing arrangements.
We considered a syndicated option but we could see varying levels of maturity in this space across our banks. Given it was the first Australian SLL, we believed it would be more straightforward to work with one bank to develop the documentation rather than to try to deal with the issues that can be posed by having a broader-based loan syndicate.
Craig Sydney Airport priced the first-ever fully syndicated SLL loan in Australia earlier this year. How did this transaction come to be and what gave the company the confidence to become the first mover in this fledgling format?
We looked at our debt portfolio with the aim of refinancing our bank-debt facilities well in advance of maturity. We started with a regular bank-debt refinancing process before overlaying the SLL element.
We have been looking at sustainable-financing options for many years. While we have implemented a number of green initiatives, we haven’t been able to identify a critical mass of green investment to fund or refinance by way of a green bond or loan.
The emergence of SLLs as a flexible alternative – relative to use-of-proceeds-based products – and the timing of our bank-debt refinancing brought the stars into alignment.
Craig What was the response from the broader syndicate to the decision to market a general refinancing first and then to tell lenders it would be an SLL?
Many of our lenders were quite excited when we introduced the SLL element and several proactively reached out with details of their banks’ sustainability funding targets. In fact, we were significantly oversubscribed from our existing lender group alone. We saw alignment between introducing the sustainability element and the banks’ own objectives.
Other banks were eager to be brought on the journey so they could learn from our transaction with a view to marketing or actively participating in similar deals by other issuers in the future. This is starting to come to fruition as Queensland Airports priced a two-bank, A$100 million SLL two months after ours.
Craig Have you received follow-on interest from your peers?
Cho Can you share some detail about the sustainability structuring aspects of the transactions?
Incorporating a financial-based pricing penalty provides real skin in the game. It enhances the credibility of our loan while incentivising management to maintain our current sustainability performance at an absolute minimum.
The way we viewed this is that the upside might be A$50,000 but the downside far greater: we would pay far more than A$50,000 to protect our brand and reputation.
We strongly believe that a penalty is important for the credibility of the product and to demonstrate our commitment to the intent of the loan.
Swiss It is possible to use internal metrics or to get an external rating. Which approaches did Adelaide Airport and Sydney Airport take?
The all-encompassing ESG risk rating provides the flexibility to work out what initiatives and improvements are meaningful to us as an airport and focus on the areas that will genuinely make a difference.
Swiss Over what sort of timeline do the improvement and deterioration metrics apply, and how often do you have to report?
If the score has deteriorated to a certain level when we submit this report, we would need to work with our lender to agree on corrective actions to be implemented on an agreed timetable. In the event that we’re unable to meet this requirement the next step would be triggered – which, as mentioned, is that the loan loses its ESG status and we would need to make a public statement to this effect. If we reach our target, on the other hand, the pricing incentive applies from the next roll date.
Throughout the year we will deliver sustainability improvements and communicate them through our annual sustainability reporting approach and engagement with Sustainalytics.
Changes are binary and not cumulative, with the possibility of fluctuating across discount, base and penalty pricing over the life of the loan depending on our sustainability performance.
PRICING AND BUY-IN
Bradburn If the airports hadn’t issued SLLs could they have used their leverage to get an equivalent price?
Craig What kind of pricing discount can issuers generally achieve through SLLs?
We wanted to make sure we had as many lenders on board as possible. This was not only to maintain our high-quality banking group but to broaden and improve the level of familiarity in the banking community to help minimise execution risk for other issuers interested in this product.
Larkin How much time and effort did it take to get your respective boards across the line for this type of borrowing?
Our board’s receptiveness to new ideas and trust in management autonomously to deliver both capital-management and sustainability outcomes certainly made it a lot easier for us.
In addition, the transparency in the pricing discount an SLL offers – relative to a green bond – was helpful in garnering internal support.
We not only had to engage the board but also executive management, because ultimately these people and their teams would be tasked with delivering sustainability improvements in conjunction with our sustainability team.
As the environmental, social and governance (ESG) finance market grows, so does focus on robust and credible standards for securities. As a relatively bespoke product based on borrowers’ sustainability targets, the sustainability-linked loan (SLL) is no different.
GANDOLFO Sustainalytics plays a key role as a provider of ESG ratings and data in rating more than 11,000 companies globally. We primarily determine our company assessments by evaluating public disclosures.
We include this information in our model and provide a rating and a report. This is updated annually and becomes the basis of our new score for the following year. This is frequently used as the key benchmark and driver of the pricing matrix for an SLL.
Bradburn How much compliance cost does it add? Have you needed to increase sustainability resources or even rebalance them with people working in the finance department?
Although it has not triggered any additional resourcing requirement, we are conscious that it does consume our sustainability team’s time – time that could be spent on other sustainability projects.
In addition, maintaining one comprehensive document aligns well with the first of the sustainability-linked loan principles (SLLPs) – which encourages issuers to link their sustainability objectives to their SLL targets.
Next time we will consider a bond format, a syndicated loan or potentially amend the remainder of our bilateral facilities. The more we can leverage this across the debt book the more attractive the pricing benefits become and the more it outweighs the compliance costs.
Craig The key difference between an SLL and a green loan or bond is that SLLs do not have to be tied to specific use of proceeds but to sustainability performance at entity level. Does this help make the product relevant to an emitter like Qantas?
We are being attacked from all angles for being a big emitter and we have limited opportunities to address this. We can’t stop using jet fuel and start flying electric planes. We have to find ways to build a portfolio of solutions to help us reduce our emissions.
We can do some of this ourselves and some of it will be enforced through ICAO [International Civil Aviation Organisation] and CORSIA [Carbon Offsetting and Reduction Scheme for International Aviation], which aim to reduce emissions in line with the Paris Agreement.
Starting in 2021, we will be capping our emissions at 2020 levels. We will need to offset any growth from these levels. Meanwhile, growth in aviation from Asia in particular will be significant in the next 10-15 years. ICAO has also said it ultimately wants emissions to be halved.
We will start to look at several key areas in more detail. The overriding one is continuing to upgrade our fleet where we can, moving towards more efficient aircraft that are typically 25 per cent more fuel-efficient than a Boeing 747. The second theme is to reduce weight on aircraft, because burning fuel is as much a function of the weight of the aircraft as the efficiency of the engine.
The third is how we can continue to use carbon offsets. We see these not as a permanent solution but as one for a period of time. The challenge with offsets, particularly in this part of the world, is that there are not enough projects in the pipeline to create the offsets we need at the price points we need.
I can see a credible connection with SLLs here, where we may seek to partner with project developers and others to help build a more assured supply chain for offsetting rather than having market risk on a carbon offset that ranges from A$0.50 to A$100. At this level, emitting 12.5-13 million tonnes of carbon a year could be very costly.
Ultimately, we need government to step up. Many of our challenges are fundamental infrastructure issues, for example around waste. We have sourced compostable cups and we can work through how to get them to Australia efficiently, how to get them onto aircraft and how to get crew to take them from passengers to recycle them. The problem is what to do with them from this point. There is limited composting recycling infrastructure.
These sorts of projects – that are less sexy but critical – are where I think SLLs could prove a useful financing tool for developers of this type of infrastructure and for us.
Biofuel is a big challenge and also an opportunity for us. It is as much a policy issue as a financial one. It is great that biofuel is significantly more efficient but the challenge is that the emission cost of energy burned to create the fuel is often more than the emission cost of jet fuel. Without the right infrastructure, in Australia and globally, its price premium will continue to challenge all airlines.
Global standards and harmonisation
Global efforts are underway to create a common language and standards for sustainable finance, with the EU taxonomy perhaps the biggest development in this space so far. Australian market participants recognise the value of harmonisation but also say it has finite boundaries.
CHO The interesting part of the EU taxonomy is that it is much more prescriptive as to what the benchmarks for sustainability will be in a variety of sectors.
However, all the parameters used are EU scenarios that focus on the EU economy. While they are useful benchmarks it is important to note this point when assessing direct applications in the rest of the world.
At the International Capital Market Association (ICMA) green-bond principle and the Loan Market Association level, where there is voluntary standard setting, there are a lot of considerations around what it means when different jurisdictions are coming up with different regulatory factors for sustainability. What has been set strictly in one region does not necessarily apply to the rest of the world.
Breen How big of a driver is reputation and how do you balance it with those priorities?
We are trying to juggle all these balls at the same time. We recognise that aviation can’t switch to an alternate way of operating. We must find a portfolio of solutions.
There is no single driver. It is now a constant agenda item at board and leadership meetings, and it will continue to be a key issue of importance to Qantas as we move into our next 100 years.
Qantas believes in taking a leadership position in managing climate risk. We have the largest consumer-offsetting carbon programme in the world but it is still small relative to what we would like it to be.
Craig Where is Ausgrid on its sustainability journey and who is driving its sustainability agenda?
Our shareholders, IFM Investors and AustralianSuper, genuinely care about sustainability. They look after superannuation money for Australians, and one in five working Australians have their superannuation with AustralianSuper. All these factors work together to encourage companies to make changes and it is pleasing to see the debt market moving in this direction too.
Our material sustainability issues are closely aligned with our strategy and business plan and address the needs of our various stakeholders. This means we have internal targets so we can be a successful organisation and meet the needs of our various stakeholders.
We are further developing our public response to sustainability and will publish our first sustainability report this year as well as setting an emissions-reduction target.
Our business is changing and we have to be part of the solution. Traditionally, the supply chain simply sent electrons one way. But the new world of energy means there will be two-way flow of electrons. The grid is the ‘internet of energy’.
In this world, generation will be more dispersed and more innovative. Traditional generators and retailers will need to adapt or they could become disintermediated as new businesses emerge. New technologies and businesses will all be facilitated by the grid.
Until the technology is in place to transmit electrons through something other than wires, the grid is ideally placed to facilitate new energy solutions. This places us in a strong position to improve the efficiency of electron flows and to reduce the cost of infrastructure, carbon footprint and customer prices.
Ausgrid is getting involved in community batteries and various other ways of distributing energy where we can smooth energy peaks to manage demand and provide a resilient and affordable solution.
If debt investors are extracting value from sustainable debt it is a win-win scenario in which an SLL provides the flexibility to be more dynamic. It would allow us the flexibility to invest in programmes to meet the changing needs of our customers.
With green bonds, the immediate hurdle is the need to find and isolate assets. SLLs support action we are already taking in addressing our material sustainability issues and, from what I’m hearing today, they do not add a significant burden to the business.
It’s worth mentioning that affordability is a material sustainability issue for Ausgrid. If we can achieve interest savings and provide value to our customers through lower energy bills it is an excellent outcome.
But our sustainability objectives are wider than affordability. We also know that our stakeholders are concerned about safety, emerging technology, having a resilient network, cyber and physical security, and community and customer engagement. An SLL allows us to choose appropriate outcomes that fit our business objectives and sustainability pathway.
Craig The property sector in Australia is one that has found it possible to identify assets for use-of-proceeds green funding. How does this affect the way a company like Lendlease thinks about SLLs?
As you suggest, we have many projects and funds that would qualify for green financing – because sustainability is a core part of Lendlease’s strategy. Part of this is about the legacy we leave with the places we create. Another part revolves around what Michael Momdjian said: it is important to our stakeholders, customers, employees, investors, tenants and shareholders.
The other aspect is that we think sustainability can provide a competitive advantage. We will deliver a better outcome in the projects we are initiating and for the people who live and work in those places.
The issue from my perspective – and the opportunity in the sustainability-linked model – is that while a use-of-proceeds financing adds value if you can’t get financing otherwise, most big corporates have good access to financing. Most importantly, what beneficial changes for the world are we making by doing a green loan or bond versus it not being green? The opportunity the SLL presents is an incentive to change behaviour, which creates the opportunity for different outcomes.
This is more likely to get corporate borrowers interested. Of course pricing is important, too, because the whole economy works on price signals. This is how you drive behaviour.
There is a big opportunity for financing to provide an incentive for borrowers to do something different and to create real difference in the world. Hopefully the SLL product will get more pick-up than use-of-proceeds types of financing and drive changed behaviour, at least for large corporates.
There is an opportunity with the SLL product for a broader conception of a sustainability-linked financing to help create other positive outcomes. A mechanism that creates incentives to deliver these outcomes should get more interest.
Ho Can a company like Lendlease extract more from positive market perception, given the contribution that office and residential properties make to greenhouse-gas emissions?
Barangaroo is a zero-net-carbon precinct. APPF Commercial is the top-ranked commercial fund in the world for the second year running. We have four of the top-10 wholesale funds ranked by GRESB. All of this is integral to the business, so what is the incremental outcome from doing green financing?
If we look at debt capital markets today, I can see there is value in green financing. It’s probably not much of a pricing benefit in primary issuance, but I think there probably is better performance in secondary trading. There is probably also slightly stickier demand.
We are not talking about big differences, but I think there is a reasonable case to be made that a green instrument may receive a more favourable reception relative to a vanilla instrument.
With SLLs, the incremental value piece comes back to what Sydney Airport and Adelaide Airport did: establishing the market for a vanilla transaction then showing what the overlay is to make it sustainability-linked.
I’m distinguishing between the case for the financing itself to be green as opposed to the underlying assets, project or fund. To me, this is where the opportunity exists – in linking sustainability performance to financing. It also depends on the issuer and the project, though.
I don’t want to suggest there is no value in use-of-proceeds financing. There will be projects and borrowers that get access to funding they may not otherwise have had because they are a green borrower or a green project. This is a good thing. What I am saying is that if you are looking at large, rated corporates, I’m not sure that use-of-proceeds financing has the same impact.
The other part is that it needs to drive behavioural change. We want our SLL to add an extra level of motivation in accelerating the implementation of current plans and also incentivise and reward new ideas that deliver sustainability improvements over and above what is currently in the pipeline.
Some companies like the fact that a green asset pool is needed for a use-of-proceeds transaction. It is a challenge, but one that can drive behaviour through governance and an increased focus on processes for maintaining and growing a green asset pool.
For example, when banks issue use-of-proceeds bonds, loans come and go as they are repaid so there is pressure to grow and maintain a green asset pool. The rationale for using different instruments varies for different companies.